“We should not deceive ourselves into thinking that when we die we shall be remembered intensively for more than a limited number of days.”
-Siegmund Warburg, 1974
Last week I started reading Niall Ferguson’s “High Financier – The Lives and Time of Siegmund Warburg.” Interestingly, but not surprisingly, Ferguson chooses to preface the 19th century history of the Rothschild and Warburg families by giving you a hint about how it all ended for central bankers in the 1970s (it didn’t end well).
If you re-read the aforementioned quote and think about it within the context of what is going on in the world of banking today (either central banking or bailout banking, or both), this is the root of the problem. These people don’t appreciate the lessons of history. They live in the now and react to whatever fire they need to put out next. There is no such thing as being proactively prepared for the long-term.
In the long-run, Keynes excused himself (and the responsibility in the recommendation of his policies) by reminding politicians that “we are all dead.” That’s a sad and pathetic way to think about leadership and legacy. It’s also one that the Western World had enough of come 1978.
Back to the Global Macro Grind…
Regardless of how I continue to think the biggest man-made money printing bazooka in world history is going to end (structurally impaired long-term growth), our risk management task this morning also needs to consider dealing with the right here and now.
In the last 3 weeks I have dropped my Cash position in the Hedgeye Asset Allocation Model from 73% to 58%, and here’s how I’m thinking of positioning into and out of what should be a disappointing European Summit “catalyst” on Wednesday:
- Cash = 58% (down from 61% last week)
- International Currency = 18% (US Dollar – UUP)
- Fixed Income = 18% (US Treasury Flattener, Long-term Treasuries, and Corporate Bonds – FLAT, TLT, and LQD)
- US Equities = 6% (Consumer Discretionary – XLY)
- International Equities = 0%
- Commodities = 0%
Looking at these positions in the order that they appear:
1. US Dollar – the US Dollar Index was down -0.3% last week, closing down for the 2nd consecutive week, but remains up +4.7% since Ben Bernanke’s beginning of the end of QE2. Despite Obama and his politicized Fed whispering everything they can about stimulus and housing bailouts last week, I think the political inertia remains at the US Dollar’s back.
2. Fixed Income – the Growth Slowing TREND we’ve been calling for throughout all of 2011 has manifested in the US Treasury Curve flattening. While the market is telling me that growth is slowing at a slower pace (bullish for the immediate-term TRADE in stocks and bearish for bonds), the intermediate-term TREND levels for both the Flattener and long-term Bonds remain bullish.
3. US Equities – my two favorite S&P Sectors (Utilities and Consumer Discretionary) are now up +11.3% and +5.1% for 2011 YTD, respectively. With Utilities finally achieving immediate-term TRADE overbought last week, I sold our XLU and stayed with the Strong Dollar = Strong America trade (US Consumption). Most of the domestic consumption stocks we like fit this same theme (MAR, TGT, etc…).
4. International Equities – not being long most things Asian Equities last week was a good call. Asian equity markets closed down another -1.2% wk/wk. Losses were led by China (-4.7%) and Thailand (-4.1%), as both struggled with heightening domestic risks associated with Growth Slowing. I’m not touching anything European Equities at these lower-highs with a 1,000 foot Keynesian pole.
5. Commodities – not here, not now. The US Dollar’s 2 weeks of weakness does not a TREND make. Inclusive of this morning’s +3.2% mean reversion bounce in the price of Copper, the Doctor remains in what we call a Bearish Formation (bearish TRADE, TREND, and TAIL). The CRB Commodities Index and Gold were both down another -1.9% and -2.8% last week. That’s good for consumers, not commodity long positions – which just saw their long “bets” (CFTC options contracts) rise +12% last week with hedge funds chasing.
On weakness (earlier in the week), I covered our short positions in US Housing (ITB), Oil (OIL), and the Financials (MS and C), so we actually had a pretty good week. No one ever went to the poor-house booking gains on the short side.
Where could I be wrong from here?
That answer obviously resides where it has for all of 2011 – led by the direction of the US Dollar Index versus the Euro.
Get the US Dollar right and you’ll get a lot of other things right. This is something our political and academic elite should think long and hard about as they try to fix their long-term policy mistakes with more short-term policies.
Sadly, in the short-term, I have no reason to believe that these people won’t continue to Deceive Themselves into thinking whatever it is that they think as the rest of us commoners are thinking about meeting payrolls.
In the short and long-run, I am fairly certain that if I do not succeed, both my family and firm will remember my mistakes intensively for plenty more than “a limited number of days.”
My immediate-term support and resistance ranges for Gold, Oil, the German DAX, and the SP500 are now $1, $86.34-88.98, 5, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
A pick up in table revenues last week from the prior week gives us more confidence in the higher end of our HK$24.5-25.5 billion (34-39% YoY growth) forecast for the full month of October. Average daily table revenue increased HK$554 million last week to HK$664 million this past week. The current rate should be considered normal since there were no holidays. The previous week was right after Golden Week which is usually very slow.
Compared to the previous week, LVS market share took a noticeable dip down to 13.4% which is also below its post Golden Week average. SJM and Galaxy were the sequential market share gainers although SJM (likely hold related) continues to track below its recent monthly trend here in October. MPEL held very well the last few months so its recent average is skewed to the high end. We believe the company is holding normal here in October and a market share around 14.5% is probably a good run rate.
Here are the numbers.
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Conclusion: Given the current state of emerging market external debt levels and maturities, King Dollar puts many emerging market corporations at risk of earnings erosion, balance sheet deterioration, and, at worse – bankruptcy.
Asian equity markets had another soft week, closing down -1.2% wk/wk on a median basis. Losses were led by China (-4.7%) and Thailand (-4.1%), as both struggled with heightening domestic risks. Asian currencies had a slightly negative week as well, closing down -0.3% wk/wk on a median basis vs. the USD. India’s rupee led the way to the downside (-2%), while gains were led to the upside be the Japanese yen – a clear sign of regional stress based upon our analysis of the mechanics driving JPY appreciation.
Asian sovereign debt markets were fairly mixed; perhaps the most notable divergence came on the short end of India’s and Indonesia’s maturity curve. Indian 2yr yields increased +12bps wk/wk after the government affirmed that it will buck the developing trend of monetary easing across the emerging market space and maintain its hawkish bias until inflation is under control. Their commentary was taken literally in the swaps market, as India’s 1yr on-shore interest rate swaps widened +15bps wk/wk. As it relates to Indonesia, expectations of further monetary easing drove 2yr yields down -27bps wk/wk.
Sovereign credit default swaps throughout the region were fairly flat on the week. A notable decliner to the downside was Hong Kong, which saw its swaps trade -7bps (-7.4%) tighter wk/wk.
***price tables can be found below***
The Least You Need to Know
- One of the themes we’ve been writing about of late is the risk of a financial crisis to sweep across the EM space driven by movements in the currency markets. Simplistically, as a country’s currency depreciates vs. the USD, both its dollar-denominated borrowing costs and its cost of servicing dollar-denominated debt increase. Corporations in certain Asian countries, like India (INR/USD down -11% over the last 3mo), who’ve loaded up on external debt over past three years amid FX appreciation and low dollar-funding costs are at risk of severe erosion in earnings growth. Moreover, they risk deterioration of their balance sheets as they are potentially forced to take on greater amounts to local currency debt to meet rising foreign obligations. Bankruptcy also remains a possibly for the weakest borrowers.
- To the latter point, Bloomberg data shows that corporations in the ten largest emerging market economies have $54 billion of foreign currency bonds coming due in the NTM – the largest sum on record (dating back to 1999). This is coming at a time where the market for issuing foreign currency corporate debt has gone completely dry ($2.6 billion in Sept. vs. a record $108 billion in 1H11). Furthermore, non-investment grade issuers were completely shut out of the market in September.
- From a borrowing costs perspective, the trend of widening credit spreads and rising interest rates continues. According JPMorgan EM bond indexes, investors now demand a 444bps premium to holding the dollar denominated EM corporate bonds over similar maturity U.S. Treasuries – up from 256bps wide in April. And at 6.36%, rates on dollar denominated EM corporate bonds are the levels last seen since June 2010 (absent a brief stint above 7% in early October).
Net-net, we continue to flag FX risk as a reason to remain cautious on both emerging market equities and credit broadly. We are of the view that a great many EM issuers are likely un-hedged, given consensus forecasts for broad-based EM currency appreciation as recently as 2Q. We’ve done a fair amount of work on this topic in recent months and we’re happy to follow up should you like to dig in further. Simply email us for more details.
- The key data point to flag out of China this week is the central government’s decision to allow some local governments to issue bonds independently. The move ends a 17-year ban, which forced China’s municipal governments to seek financing via arms-length entities (amassing $1.7 trillion in debt in the process). The program is rather small in both size (CNY22.9 billion) and scope (two cities; two provinces), but we would expect to see it expanded upon in the coming months as LGFV debt maturities mount.
While by no means a cure-all (the property market is still showing signs of cracking), allowing the local governments to issue bonds directly to investors will: a) diversify financial risk away from the banking system and b) smooth the systemic balance sheet mismatch that stems from issuing short-term paper to fund longer-term infrastructure initiatives.
- The key data point to flag out of Japan this week is/are the government’s latest fiscal stimulus measures. First, it was announced that the Japan will bolster by +25% funds allocated for the recently-announced Japan Bank for International Cooperation fund to ¥10 trillion. The initiative was set up to help Japanese corporations cope with an elevated yen by aiding in overseas M&A. Secondly, Prime Minister Yoshihiko Noda approved a ¥12.1 trillion third supplementary budget to help fund both quake rebuilding and domestic capex (with the intent of preserving jobs).
As we have seen for the latter part of the past twenty years, the Japanese government continues to be the only source of incremental demand in the ailing Japanese economy. Our secular debt and demographic work on Japan suggests that this phenomenon is likely to continue as growth remains structurally depressed over the long term.
- The key data point to flag out of India this week is the pervasive hawkishness sweeping across various levels of Indian government. This week, Chakravarthy Rangarajan, chairman of the Prime Minister’s Economic Advisory Council, affirmed the country’s need for higher interest rates, in spite of his view that inflation is being largely triggered by elevated food prices and/or supply-side constraints. His comments were supported by additional commentary out of Finance Minster Pranab Mukherjee, who said that India’s inflation “may be under pressure until December”, and that the RBI “need not follow the policy of reducing interest rates being pursued by some of its counterparts abroad.”
These comments echo RBI Governor Duvvuri Subbarao’s statement last week which read: “As much as we look at what other central banks are doing, we take into account our own domestic circumstances and the domestic context in formulating policy,” – suggesting that India is unlikely to follow suit and join the rate cutting cycle anytime soon, given that, while slowing, WPI is likely to remain elevated on an absolute basis over the intermediate term.
- A key data point we wanted to flag out of Thailand this week was the progression of the current nation-wide flooding. Since July, these floods have spread across 61 of the country’s 77 provinces, claimed 300 lives, and forced work stoppages at over 14,000 businesses – including 930 production facilities across 28 provinces. As of the latest estimate, the flooding is anticipated to cost $3.9-$5.1 billion in damages and lost economic growth (subtracting 100-170bps from GDP) .
These floods, particularly if they breach the capital of Bangkok (Oct 29-31 projection) could have a lasting impact on Thai economic growth. As it stands currently, they are already having an impact on global supply chains. Thailand is the world’s largest producer of hard-disk drives, the largest exporter of rice and rubber, and the second-largest exporter of sugar. Companies like Apple, Toyota, Tohsiba, and Hitachi have all been forced to suspend production of key parts and/or move the assembly elsewhere.
We don’t expect BYI to report a truly impressive quarter until FQ3 but the near-term bar has been lowered too much.
As we wrote about on October 5th “BYI: WE’VE GOT THAT GOOD FEELING,” we think BYI will produce an estimate-beating quarter. Management resets expectations at significantly lower levels on their last call. They weren’t expecting it but the stock resets much lower as well. Since we wrote our note about 2 weeks ago, expectations have crept up by a penny to 43 cents for BYI’s F1Q12 and the stock has moved much higher (up 21%), so the quarter may not be the catalyst it was.
More importantly, we are inching closer to a big pick-up in new openings beginning in the March quarter. More are on the way. Visibility on Italy and Canada should get clearer in the next few months and we expect all of the suppliers to discuss potential opportunities in MA, FL, Greece, Taiwan, Japan, Vietnam, South Korea, and other markets. The new market thesis may come back into investor focus.
BYI should see strong flow through not only in their new unit sales but also in their systems business – an important differentiating factor for the stock in our opinion. Their systems business is a critical lynchpin in our positive BYI thesis as visibility and growth should improve dramatically in calendar 2012. Despite higher margins and a recurring component to systems revenue, that segment has been viewed as a bit of a black hole by investors due to the unpredictability. We expect that to change next year.
We estimate that BYI will report $191MM of revenue and $0.45 cents of EPS after close on 10/26.
- $62MM of gaming equipment sales at a 43% gross margin or $27MM
- 3,250 new units
- 2,150 units in NA with about 2k coming from replacement units. There are very few new openings and expansions in the September quarter
- 1,100 international units
- 3,250 new units
- ASP of $16,150
- $9MM of parts, used and conversion sales
- Systems revenue of $45MM at a 72% gross margin
- Gaming operations revenue of $84.5MM, up $2MM sequentially with a 74% gross margin. The September quarter has historically been better than the June quarter for gaming operations at BYI regarding revenues and margins
- Other stuff:
- SG&A: $58MM
- R&D: $23.5MM
- D&A: $5.5MM
- Net interest expense: $3.4MM
- Tax rate: 36.5%
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